When is the right time to buy oil and gas stocks? Well, the argument could be made that today may not be the best time ever in the history of the market, but it's still a pretty good one. With oil and gas prices low thanks to less than stellar demand growth and a surge of supply, stocks in the industry look quite cheap.
But perhaps you're hesitant to make that oil and gas purchase because you are still skeptical about a recovery. If that's the case, there are a few stocks worth watching to measure the industry's pulse. National Oilwell Varco (NYSE:NOV), FMC Technologies (NYSE:FTI), and Emerge Energy Services (NYSE:EMES) are three that will help you better undserstand which way the wind is blowing in the oil markets.
The big picture for oil and gas equipment
The indicator that most people rely on when gauging the health of anything oil and gas is the price of the commodity. However, while commodity prices will play a pretty large role, they aren't really a panacea for ailing companies in the oil and gas equipment space. Instead, the more important indicator is drilling activity. As long as producers are out there putting a drill bit in the ground, equipment companies will be needed. Drilling activity can be high when prices are low, and can also experience downturns when oil and gas prices are high, so don't immediately associate oil and gas prices with the ultimate fate of equipment companies.
That said, here's why those three companies mentioned above are worth watching.
National Oilwell Varco: This one is pretty much a no-brainer, because it is the quintessential oil and gas equipment manufacturer. Just about any piece of equipment needed for the physical drilling of a well is manufactured by National Oilwell Varco -- it's even getting into supplying other large ticket items with equipment, such as floating production, storage, and offloading facilities. By last count, the company controlled more than 60% of the market for supplying offshore rigs with drilling equipment.
There has been quite a bit of concern lately regarding the decline in drilling activity, the delayed delivery of many new offshore rigs, and, for National Oilwell Varco specifically, a declining backlog of manufacturing work. This is definitely a concern for the next several quarters, but the truth is that equipment gets used and needs to be replaced, and additional equipment will be needed to meet growing oil and gas demand. With a strong balance sheet and a deeply embedded customer base that needs NOV's standardized parts to replace those currently in use, the company stands to do well when demand picks back up again.
FMC Technologies: If National Oilwell Varco is the barometer for the entire oil and gas equipment industry, then FMC technologies is a more specific barometer for just the offshore industry. A vast majority of the equipment manufactured by FMC consists of things like blowout preventors and "christmas trees" -- flow control valves -- to be used on the ocean floor, and a large portion of this equipment is used in deepwater drilling projects. Today, FMC controls just under half of this subsea equipment market.
One thing that bodes well for FMC over the next couple of years is that many of the deep sea projects that will require the company's equipment are already under development, and larger oil and gas producing companies are much less likely to cut capital expenditures from these projects because they have already invested large amounts already. However, the reduction of exploration budgets today could come back and bite the company later, as it could translate into fewer development projects several year from now.
Luckily for FMC, the company maintains a strong balance sheet and has more than enough in cash to cover any short-term struggles, with a very manageable debt portfolio. So when it does get hit with hard downturns in the offshore market, it appears to have the financial strength to ride them out, potentially even taking market share from some of its competitors.
Emerge Energy Services: Emerge is the polar opposite of FMC Technologies -- it's a much more accurate gauge of the U.S. market for land oil and gas equipment, even though the only equipment it provides to the industry is sand.
One thing that is becoming eminently clear is that hydraulic fracturing is and will remain a major part of U.S. oil and gas production for quite some time. To access shale formations, drilling companies use a fluid that contains a lot of sand. As the prices of oil and gas have plummeted, so too has drilling activity, and, by default, sand demand.
One thing that makes this industry so intriguing, though, is the fact that production from hydraulic fracturing can change so quickly. The time it takes to drill and develop can be measured in days, not years like large offshore oil projects, and the decline rates of these wells are quite high. What this means is that the U.S. land drilling market can react rather quickly to oil prices. One way to gauge that is to look at the amount of sand that is heading to the oil patch; by keeping track of what is going on at Emerge, you can get a rough idea of whether U.S. production is ramping up or slowing down.
What a Fool believes
Companies that operate in the background, like oil and gas equipment providers, are a great way for you to get exposure to the energy markets while earning much higher returns on capital than you might with companies that are directly exposed to commodity prices. National Oilwell Varco, FMC Technologies, and Emerge Energy Services are three companies that not only display some very compelling traits as potential investments, but also act as gauges for three parts of the oil and gas equipment industry worth watching.
The Motley Fool recommends FMC Technologies and National Oilwell Varco. The Motley Fool owns shares of National Oilwell Varco. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.